Small and Medium Enterprises (SMEs) are a key factor in the economic development and innovation. The core of the political and economic transformation of any country is the creation of the private sector, the development of entrepreneurship and creation of SMEs. They are considered to be one of the principal driving forces in economic development. SMEs stimulate private ownership and entrepreneurial skills, they are flexible and can adapt quickly to changing market demand and supply situations, they generate employment, help diversify economic activity and make a significant contribution to exports and trade. SMEs also play an important role in innovation and the high-tech business, due to their flexibility and creativity many of them became large businesses.

But despite their significant role in the development of an economy they face many problems and one such problem is the timely availability of working capital. Funds employed in current assets constitute working capital. It is infact referred to as life-blood’ or ‘controlling-nerve’ of the unit. The concept used for working capital may be gross working capital or net working capital. Gross working capital constitutes current assets, whereas net working capital means current asset minus current liabilities. The above stated problem arises mainly due to delay in payments made by the debtors. The funds of many SME industrial units are blocked in receivables. As a result, recycling of funds is affected and production suffers. In a competitive environment, it must be ensured that receivable dues are realized with utmost expedition. The SME units will have to make special efforts for collection of their dues for their growth. 1

Another concern for the SME’s is to minimize their dependence on fund-based credit. In order to fulfill the working capital requirements of the business, the entrepreneurs normally take up various types of fund-based credit facilities namely cash credit, overdraft, demand loan, bill discount/purchase etc. from banks, but this sometimes increases their operating cost and hence makes them less competitive. The funds lent to the unit get paid on realization of sale proceeds towards the end of the production cycle, but it creates a problem for the unit in case payments are delayed from the debtors. Thus working capital facilities are intended to finance current assets.
Other important components of working capital are cash and inventory. Cash is one of the most important components of the working capital. It allows a business to meet its day-to-day expenses and

inventory is a list for goods and materials, or those goods and materials

themselves, held available in stock by a business. Problems related to the aspects are discussed in the report. The report also discusses about some of the initiatives taken by the Government of India in this regard like setting up of SIDBI, NABARD and other schemes. Finally the report concludes with the suggestions and conclusions.




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The problem which is addressed in this study is one of the most talked about issue i.e. the problem of timely availability of working capital to SME’s. The above mentioned problem will be addressed in this study by a detailed literature review from various available sources and through a case study of an SME facing this problem.

SME’s form the back bone of any nation whether developing or developed. But the irony is that the real issues and problems that SME’s have been facing are not addressed as they should be. One such problem is the problem of timely availability of working capital. Finance forms the life line of any business and if it not available when needed the most all day to day operations are effected and this in turn leads to various other problems (the worst result due to non-timely availability of working capital could be the closure of the enterprise). So it is significant to understand the business environment and how it creates a problem like scarcity of working capital of an enterprise. The study undertaken is also important so as to ascertain the impact of non-availability of working capital in time to SME’s, on SME’s, large enterprises and the economy as a whole.

The scope of the study is confined to study the reasons for non-timely availability of working capital to SME’s and resultant impact it has on SME’s, large enterprises and the Indian economy as a whole. The study will be undertaken based on literature review from the available resources like national daily newspapers, financial newspapers, websites of various entities like SIDBI etc, certain magazines like the analyst (ICFAI press) and any other 5

resource available. The study will also cover a case study of an SME which is facing the above mentioned problem. The limitation of the study is that the study is based on only literature review and no survey or field study will be conducted, hence limiting the scope of the study.

Small is beautiful but is it Powerful? Yes, say the SMEs. SMEs have been stories that happened away from the public eye, not seen and hence, not known. But can one ignore the silent march of a multitude, relentlessly servicing the behemoths. The Report Card of the SSI Sector reads thus: The growth recorded by SSI in India is 2% more than any other sector; it accounts for 40% of the country’s GDP, 35% of Direct exports, 15% of Indirect Exports (through Merchant Exporters, Trading Houses & Export Houses) and employs more than 20 million people. The SSIs needs just Rs. 60, 000 – 70, 000 to generate employment for one man, while for the same a whopping 5-6lakhs is required for other sectors. An investment of Rs.1 million in fixed assets can generate Rs.4.62 million of Goods or Services with an approximate value addition of 10%, investment of Rs. 1Lakh can provide employment to 4 people. The exports from SSI sector has ridden on the performance of garments (readymade garments, woollen garments and knitwear), leather and gems and jewellery, sports goods, plastic products, processed food units from this sector. It is also pertinent to note that the non-traditional products constitute a massive 95% of the SSI exports. Small and Medium Enterprises (SME) sector in India is the key driver of the nation's economic growth with a contribution of over 40 per cent to the country's industrial output and around 35 per cent to direct exports. It accounts for over 90 per cent of the industrial units in the country. In terms of employment, this sector plays a very crucial role, being the second largest employer after agriculture. The impressive performance has been in spite of the inadequacies in capital, technology and marketing. In the current economic 6

slowdown, SME sector has been hit very hard due to rising interest rates and financial crunch.

As a result of this economic slowdown and global markets collapsing there is a decline in the cash reserve and the working capital becomes more difficult and has resulted in cut down on orders and piling up of pending payments. The severely affected sectors are Gems & Jewellery, textiles, auto parts and handicrafts. SMEs in the country are facing numerous problems relating to basic infrastructure facilities like uninterrupted power supply, efficient rail-road connectivity, etc. This vital sector needs Government support in terms of financial, regulatory, procedural reforms for sustaining its growth in the current economic slowdown. Although SME’S can be defined in a number of ways but in accordance with the provision of Micro, Small & Medium Enterprises Development (MSMED) Act, 2006 the Micro, Small and Medium Enterprises (MSME) are classified as: (a) Manufacturing Enterprises- The enterprises engaged in the manufacture or production of goods pertaining to any industry specified in the first schedule to the industries (Development and regulation) Act, 1951). The Manufacturing Enterprise is defined in terms of investment in Plant & Machinery.

(b) Service Enterprises: The enterprises engaged in providing or rendering of services and are defined in terms of investment in equipment. The limit for investment in plant and machinery / equipment for manufacturing / service enterprises, as stated as under: MANUFACTURING SECTOR Enterprises Micro Enterprises Investment in plant & machinery Does not exceed twenty five lakh rupees


Small Enterprises Medium Enterprises

More than twenty five lakh rupees but does not exceed five crore rupees More than five crore rupees but does not exceed ten crore rupees

TABLE 1.1 CLASSIFICATION OF SME’S IN MANUFACTURING SECTOR SERVICE SECTOR Enterprises Micro Enterprises Small Enterprises Medium Enterprises Investment in equipments Does not exceed ten lakh rupees: More than ten lakh rupees but does not exceed two crore rupees More than two crore rupees but does not exceed five core rupees


The Industries Development And Regulation Act, 1951, defines SMEs according to limits in Investment in Plant & Machinery. The small-scale sector, in India, comprises of: The abstractness in defining a SME presents difficulty in identifying them , formulate & implement suitable policies for them. The limit on investment in Plant & Machinery and a plethora of laws governing (58 laws in 7 different categories) them, some of the SSIs seek refuge in remaining small inspite of opportunities to grow. The small size, opacity of the firms and their lack of awareness have bred the following hindrances to their growth:

1. Under-utilization of Capacities. 2. Inadequate and Untimely Credit Flows. 3. Inability in Technology upgradation. 8

4. Inefficient raw material procurement. 5. Inability to Market Finished Goods. 6. Ineffective monitoring and feedback mechanism.

COMMON CHARACTERISTICS OF SMEs: (a) Born out of individual initiatives & skills
SME startups tend to evolve along a single entrepreneur or a small group of entrepreneurs; in many cases; leveraging on a skill set. There are other SMEs being set up purely as a means of earning livelihood. These includes many trading and retail establishments while most countries continue SMEs to manufacturing services, others adopt a broader definition and include retailing as well.

(b) Greater operational flexibility
The direct involvement of owner(s), coupled with flat hierarchical structures and less number of people ensure that there is greater operational flexibility. Decision making such as changes in price mix or product mix in response to market conditions is faster.

(c) Low cost of production
SMEs have lower overheads. This translates to lower cost of production, at least upto limited volumes.

(d) High propensity to adopt technology
Traditionally SMEs have shown a propensity of being able to adopt and internalize the technology being used by them.

(e) High capacity to innovate export:


SMEs skill in innovation, improvisation and reverse engineering are legendary. By being able to meet niche requirements, they are also able to capture export markets where volumes are not huge.

(f) High employment orientation:
SMEs are usually the prime drives of jobs, in some cases creating upto 80%. Jobs SMEs tend to be labor intensive per se and are able to generate more jobs for every unit of investment, compared to their bigger counterparts.

(g) Utilization of locally available human & material resources
SMEs provide jobs locally and hence utilise manpower available locally. Since it is available for them to transport materials over long distances, they often improvise with materials which are available locally.

(h) Reduction of regional imbalances
Unlike large industries where divisibility of operations is more difficult, SMEs enjoy the flexibility of location. Thus, any country, SMEs can be found spread virtually right across, even through some specific location s emerge as ‘clusters’ for units of a similar kind. Nevertheless, the spread of SMEs is a fact which enhances their attraction from a national or regional policy.



Any industrial establishment requires broadly two kinds of funds. The first one is longterm funds which are required for the purchase of fixed assets such as land, building, machineries, electrical installations, start up expenses, development expenses, purchase of goodwill, purchase of furniture, purchase of vehicles and other items to bring the establishment into operation. The second kind is short-term funds. These are required to meet the needs of day-to-day expenses such as raw-materials, stores, power and fuel, salaries, wages, administrative expenses, interest, sales and distribution expenses and other expenses to produce the saleable goods, upto the realization of the sale proceeds. Till the sale proceeds are realized, the inventory is built up to facilitate smooth production and outstanding bills i.e. debtors are also financed by the short-term funds. In due course the establishment also gets some credit from their supplier which is indirect financing of the short-term funds. Funds employed in current assets constitute working capital. It is infact the life-blood’ and ‘controlling-nerve’ of the unit. The concept used for working capital may be gross working capital or net working capital. Gross working capital constitute current assets, whereas net working capital means current asset minus current liabilities. Working capital, also known as net working capital, is a financial metric which represents 11

operating liquidity available to a business. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. It is calculated as current assets minus current liabilities. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit. A company can be endowed with assets and profitability but short of liquidity if its assets cannot readily be converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable and cash. How much working capital will be required by a particular industrial undertaking will depend upon the production cycle i.e. from the time raw material is purchased to the time goods are sold and cash is realized (operating cycle). Therefore, the working capital for a unit would mean the total current assets it has to hold. Operating cycle depends upon the following actions: • • • • • • • • • • Seasonality Stock cut/safety Economy of purchases Bunched receipts Production process Disturbance in production process Disturbance in sales due to transport problems Disturbance in sales due to depression in market Terms of sale and Slow billing (slow collection etc.)

Many newly started units become sick or run into fatal problems due to defective financial plan. The plan adopted may fail to provide adequate capital to meet the needs of both fixed and working capital, particularly the later. There are instances where units have been able to obtain sufficient funds to buy a plant but failed to equip the same and conduct production operations successfully because of faulty assessment of working capital needs. 12

As far as the requirement of purchase of fixed assets is concerned, it is almost certain what items are to be purchased and how much amount will be involved and usually the decision for this expenditure is taken in the very beginning. If a borrower approaches for funds for this purpose, bankers examine the technical feasibility, economic validity and managerial competency before deciding to sanction the loan. There is not much problem to sanction it, provided the banker is satisfied about the earning capacity and the repayment schedule. Both the bankers as well as borrower have to decide about it only once. On the other hand, amount of working capital required by the concerned unit may vary from time to time, depending upon various factors such as cost of raw material, utilization capacity, marketing arrangements etc. It is on account of this fact that entrepreneurs usually spend most of their time to manage working capital requirements. Prior to nationalization, banks largely financed medium and large-scale industries and traders. There was inequitable distribution of credit amongst different sector and geographical areas. The security oriented-approach of banks resulted in credit being available only to the well-to-do, thus leading to concentration of economic power in their hands. Even upto 1973, industries did not have to plan their credits since it was easily available against collaterals. Banks on their part did not think of credit planning because banks were flush with funds.

Decisions relating to working capital and short term financing are referred to as working capital management. These involve managing the relationship between a firm's shortterm assets and its short-term liabilities. The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses. By definition, working capital management entails short term decisions - generally, relating to the next one year periods, which are "reversible". These decisions are therefore not taken on the 13

same basis as Capital Investment Decisions rather they will be based on cash flows and / or profitability. One measure of cash flow is provided by the cash conversion cycle the net number of days from the outlay of cash for raw material to receiving payment from the customer. As a management tool, this metric makes explicit the inter-relatedness of decisions relating to inventories, accounts receivable and payable, and cash. Because this number effectively corresponds to the time that the firm's cash is tied up in operations and unavailable for other activities, management generally aims at a low net count. Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital. These policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are acceptable.

Cash management. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs. Inventory management. Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials - and minimizes reordering costs - and hence increases cash flow.

Debtor’s management. Identify the appropriate credit policy, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa).

Short term financing. Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors to cash" through "factoring".


The funds of many SME industrial units are blocked in receivables. As a result, recycling of funds is affected and production suffers. In a competitive environment, it must be ensured that receivable dues are realized with utmost expedition. The SME units will have to make special efforts for collection of their dues for their growth. As India’s economy begins to slow after expanding by at least 9% for the past three years, some large companies are delaying payments to suppliers, resulting in some of these suppliers going out of business or laying off jobs, according to associations that represent so-called small and medium enterprises, or SMEs. Even in normal course of business and a stable economic environment, large enterprises always try to take advantage of SME’s by delaying their payment. In fact they use this money to meet their current working capital/finance needs in order to run their business. Such defaults also highlight the violation of a law passed in 2006 to protect small enterprises. According to the Micro, Small and Medium Enterprises Development Act, large companies that source products or services from small enterprises have to pay them within 45 days. While the law says SMEs can complain to centres in their respective states in case of non-payment and that such complaints will be addressed within 90 days 15

of being filed, the associations claim that this is rarely the case as a matter of fact, most entrepreneurs do not seem to have any information about the above stated law. Few states like Tamil Nadu even have a complaints body. The complaints body in Tamil Nadu received 500-600 complaints in the past year, mostly against companies in the automobile, heavy equipment and power equipment businesses.

According to Gandhi Kumar,

president, Tamil Nadu Small and Tiny Industries

Association, thus far, only 42-45 complaints have been addressed. Maharashtra, which has at least 1,400 industrial estates out of which SMEs operate, is yet to set up a complaints body. Such bodies exist in Uttar Pradesh, Andhra Pradesh, Gujarat and the north-eastern states but they’re barely functional. It is an established fact that in most cases payments are made after six months, and sometimes after a year, exceeding the 45-day credit period stipulated by law. Large companies are also required to mention payments to small enterprises according to the Companies Act. A random survey of seven large companies based out of Uttar Pradesh showed that this wasn’t being done, said Praveen Saldana, president of Indian Industries Association, which has 45,000 direct and indirect members with representations from handicraft, leather and glass manufacturers. Such buyers conveniently blame quality, he added. “After receiving their material, many big companies withhold payment saying the material is under inspection.” “If you want to delay payment, you can have many reasons,” said Prithvi Raj, who runs a small packaging firm, Bharat Printing and Packaging in Bangalore. “(Big) companies have always delayed payments by 90-180 days. Such unjustified delay in payments can be cited as one of the reasons for drying up the working capital of the SME’s. The economic slowdown has now put them in a even tighter spot as the priorities of this sector are pushed too far below the ladder.” India’s industrial landscape is dotted with SMEs. They account for 40% of the country’s manufacturing output and almost half its exports. In 16

Maharashtra, for instance, SMEs produce around 8,500 products from plastic to scientific appliances. They contributed 80%, or Rs30,000 crore, to the state’s tax revenue. “Because the units do not get credit and payment on time, about 1.82 lakh units have closed down in Maharashtra in the past eight years,” said Rakshpal Abrol, president, Bombay Small Scale Industries Association, which has 4,600 individual members and 40 factory associations as its members.

“Since there is no council set up yet, we have nowhere to go to file complaints,” he added. And the law is silent on several important aspects, said Damodar Avanoor, vicepresident, Kerala State Small Industries Association. “The Act explains how a respondent can go on appeal but lacks clarity on how an award can be executed.” Almost all SME associations agree to the fact that while cases of non-payment are rising, many people are hesitant to go on record for fear of being boycotted by companies. But a more serious problem, they maintain, is the lack of awareness about the law itself. A sample survey of 250 small entrepreneurs conducted by Milagrow, a Noida-based firm that assists small businesses, shows that between 62% and 80% of the respondents didn’t know that a law exists to protect payment rights. “The facilitation council (the complaints body) exists only in name, lacking both competence and manpower. Big companies have the clout of purchasing power. On the other hand, small players depend on their large customers, who constitute 60-70% of their revenue base so they rarely want to lodge a complaint,” said Rajeev Karwal, Milagrow’s chief executive officer. In states such as Kerala, about half the defaulters are government-owned companies; in Tamil Nadu, government firms account for 15% of defaulters. The number is a high 80% in the north-eastern states, said Ram Swaroop Joshi, chairman of Federation of Industries and Commerce of the North East Region.


Government-owned companies can get away with this, said Bhardwaj, because “the executive machinery in states, including the development commissioner, district magistrate and police, hesitate to take action against their fellow officers in public sector undertakings, even after judgements by facilitation councils”. SMEs that are brave enough to take on state-owned firms suffer the consequences. A.V. Johnson, owner of an SME in Kerala, was forced to shut shop when several customers delayed payments. He was able to restart operations last year when the Kerala Road Transport Corp., one of the defaulters, paid a claim of Rs22 lakh. Since then, the stateowned firm has blacklisted him. Rama Devi Kanneganti’s battle with a state-owned firm is far from over. The managing partner of Hyderabad-based Shivani Engineering Industries, which assembles buses, filed a case against the Andhra Pradesh State Road Transport Corp. over non-payment of dues running into a few crores of rupees. Even before her complaint could be addressed, the corporation struck Shivani Engineering’s name off a list of authorized suppliers. Subsequently, Kanneganti, who also heads the Association of Lady Entrepreneurs of Andhra Pradesh, managed to get a favourable order from a state court allowing her to continue supplies to the corporation. “It’s a vicious cycle,” said Kanneganti over the phone from Hyderabad. “The government wants to encourage this sector through various schemes, but the implementation of the law is very poor. We need a mechanism where our grievances are addressed immediately.” As discussed in the above sections, debtors form a sizeable portion of the working capital of a company but delay in payments by debtors of the firm, make the task of managing working capital for a firm very difficult, as the money is not there when needed. This results in a sudden requirement of funds for the company and hence leads to a mismatch between demand and supply.


In order to fulfill the working capital requirements of the business, the entrepreneurs normally take up various types of fund-based credit facilities namely cash credit, overdraft, demand loan, bill discount/purchase etc. from banks. The working capital requirements relate to the processing, production and sale of goods/services and are granted for bridging the financial gaps in the production cycle of the borrower unit. The funds lent to the unit get paid on realization of sale proceeds towards the end of the production cycle. Thus working capital facilities are intended to finance current assets. These facilities are granted for a short period, generally up to one year, and renewed or rolled over from year to year depending upon fresh assessment of working capital requirements of the unit. Working capital loan funds provide a business the cash it needs to keep growing until it can cover all operating expenses out of revenue. Without a working capital loan most businesses are unable to generate enough revenue to stay afloat. These funds provide access to cash which can be used to pay rent or mortgage payments, utilities, marketing expenses, inventory, employees, etc. Obtaining capital through this method can be difficult for many businesses, so it is essential to have good business credit scores established. Building solid business credit scores are the key to obtaining substantial working capital loan funds that can be used to grow a business. Not all types of working capital require 19

business credit history, but it is important to have that in place. Lenders use the business credit scores just like they use personal credit scores when evaluating whether the businessman is worthy of receiving capital. Making sure that the lines of credit help build one’s credit will put him in the right direction to getting the loans that a business needs to succeed. There are five common types of a working capital loan. They include: Equity: Obtained from personal resources like equity in your house, funds from friends or family members, or from angel investors. Trade Creditor: A trade creditor will extend a loan to the buyer so that he can purchase a large quantity from the creditor’s place of business. They will often check your business credit history before extending credit to you. Factoring/Advances: You can sell future credit card receipts for instant capital if your business accepts credit cards. Another option is to sell your accounts receivable to a factoring company who handles the collection. Line of Credit: Your business can apply for a bank line of credit, giving you the ability to borrow for short term needs. Good business credit scores will assist with your approval for a line of credit. Short term loan: A bank can also extend credit to allow you to purchase inventory for a season. This note will typically be less than a year. Again, good established business credit scores will nearly guarantee access to this kind of funding. Some of the fund-based loans provided by banks to the needy SME’s in order to fulfill their working capital requirements are: Overdraft: Overdraft means drawing from the current account, over and above the credit balance therein. A limit for overdraft is sanctioned for a specific purpose and period. Overdraft facility may be secured (against government securities, company shares/bonds, banks own fixed deposits etc.) or unsecured. Drawings can be made upto the sanctioned 20

limit and interest is charged at a mutually agreed rate on the daily debit balance in the account. Cash credit: It is a running account for drawing within a specified credit limit sanctioned by the bank against the security of stocks (raw material, stock-in-progress, finished goods, stores) and book debts which are pledged/hypothecated by the borrower. The borrower submits the statements of charged assets at periodic intervals (mostly monthly) and the bank permits the borrower to draw cash/cheques within the drawing power (value of the charged assets less stipulated margin) that the cash credit account can sustain. The borrowing unit uses the cash credit account for meeting the working capital requirements and also deposits his sale proceeds in the account. Interest at an agreed rate is charged on the daily debit balances, which varies from day to day as per withdrawals and deposits of funds in the cash credit account. Demand loan: A fixed amount is advanced to the borrower initially for a specific purpose for a short period. No subsequent withdrawals are allowed to the borrower as the loan is a one time facility subject to periodic or lump-sum repayment along with the interest applied to the account monthly or quarterly. Another loan may be granted by opening a fresh account and obtaining fresh documentation. Bills purchase/Discount: Bills of exchange are drawn by a seller upon the purchaser, as per the credit terms agreed upon. Following are the typical features of bills purchase/discounting facility: • • The seller submits the bills alongwith the transportation receipts

(railway/lorry/air/bill of lading) to his bank. The bank sends the documents to the drawee through the banking channel for presentment for payment (demand bill) or presentment for acceptance (usance bill). • The seller’s bank purchases the demand bills and discounts the usance bills by crediting the seller’s account with the amount of the bills minus the interest discount and handling charges. 21

Advances against bills are adjusted on recipt of the proceeds of the relative bills. In case of non-payment of the bills on the due date additional interest is charged to the seller and the amount of the bill is also recovered if it remains unpaid.

• •

The bank ensures that bills purchased or discounted are genuine and represent actual movement of goods from the seller to the purchasers. Accommodation bills are the bills that are drawn without any movement of goods from the drawer to the drawee, with a view to obtain bank finance fro non-trading purpose. Banks do not fianance such bills and also take care extreme care in financing clean bills which are not accompanied by documents of title to goods and transport receipts evidencing movement of goods.


Although there are various options available to the entrepreneur as stated above to finance the working capital requirements, it does not often help the entrepreneurs to meet the working capital requirements in time because some of the following reasons:

One of the most common reasons is that many entrepreneurs are not even aware of the ongoing schemes and methods to finance the working capital requirements. Secondly, it ultimately increases the cost of their products and thereby making them less competitive. Sometimes the businessman is unable to furnish one or more details required by the banks in the form of documentation for the approval of the credit facility. Most of the banks, want to have with them less number of productive customers who are sufficient to give them more business volume rather than having a large number of small customers. This approach of the banks also acts as a hindrance for the entrepreneurs to obtain credit. Hence, the large enterprises are in win-win situation as even the banks favor them.

• •


One of the common reasons of untimely availability of credit is that when a company is unable to satisfy the bank on its ability to repay, creditworthiness and such related criterion.

Economic conditions such as prevalent now days coupled with high rates of interest, create a problem even for creditworthy companies to obtain credit as banks are over-cautious in lending to borrowers and this lack of confidence among the borrowers and lenders makes it very difficult for the companies to finance working capital requirements in time.

Cash is one of the most important components of the working capital. It allows a business to meet its day-to-day expenses. Companies cannot be entirely run on cash basis as credit also forms an indispensable part of a business. But companies do not have enough cash generation so that it becomes sufficient to meet their cash related working capital requirements. Another point to note here is that cash has no substitute. SME’s mostly operate on low volumes and thin margins and hence they require cash regularly and often face cash related problems mainly because of the following reasons: • Cash is required on daily basis i.e. for day-to-day expenses like conveyance bills, stationary, tea and snacks, payments made to various governmental agencies (for obtaining license, permissions or for some other purpose), security deposits, fuel expenses for DG sets, maintenance of vehicles and other assets, purchase of petty items, making salary and wage payments etc. This makes cash management extremely necessary as it has high probability to fall short of demand.


SME’s, especially new entrants or small companies generally do not get credit from their supplier; also they are sometimes enticed by the additional cash payment discounts offered by the suppliers. This means they generally have to buy a majority of their raw material against cash payments. Even if they enjoy some credit from the suppliers (i.e. only after a certain period of time or certain number of transactions) it is far less than what SME’s have to provide to their buyers.

SME’s generally operate on low profit margins, so they want to cash on every opportunity to make/save money. Hence sometimes due to low volumes and thin profit margins they are forced to take decisions like to stock surplus raw material, which is consumed regularly, when the prices are low and are expected to rise in the near future. Also most of the large enterprises are following the best of the available techniques for their inventory management like JIT, hence it is the supplier (SME’s) that have to bear the brunt by keeping adequate inventory to adhere to the supply schedules provided to them. This activity consumes cash/investments which create a shortage of funds for the company and it also increases the holding cost for the company.

Labor is to be paid for their efforts on a monthly basis and it does not work on the principle of credit. Wages are mostly paid in cash and in many cases even salary is paid in cash as people employed do not usually have enough savings with them, hence they want their wages/salary in time. This means additional pressure and cash requirement every month. Where as in large enterprises people employed are hardly paid in cash and in case of any eventuality they always have support from the financial institutions/banks to finance their current needs.

Hence the above listed points make it imperative to have a regular cash flow for SME’s as against large enterprises as otherwise it could mean extra cost for the company. The aim should be to minimize the cost of financing the working capital requirements.







Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a business.

THE REASONS FOR KEEPING STOCK There are three basic reasons for keeping an inventory: 1. Time - The time lags present in the supply chain, from supplier to user at every stage, requires that you maintain certain amount of inventory to use in this "lead time" 2. Uncertainty - Inventories are maintained as buffers to meet uncertainties in demand, supply and movements of goods.


3. Economies of scale - Ideal condition of "one unit at a time at a place where user needs it, when he needs it" principle tends to incur lots of costs in terms of logistics. So bulk buying, movement and storing brings in economies of scale, thus inventory.

INVENTORY EXAMPLES While accountants often discuss inventory in terms of goods for sale, organizations manufacturers, service-providers and not-for-profits also have inventories (fixtures, furniture, supplies ...) that they do not intend to sell. Manufacturers', distributors’', and wholesalers' inventory tends to cluster in warehouses. Retailers’ inventory may exist in a warehouse or in a shop or store accessible to customers. Inventories not intended for sale to customers or to clients may be held in any premises an organization uses. Stock ties up cash and if uncontrolled it will be impossible to know the actual level of stocks and therefore impossible to control them.

Whilst the reasons for holding stock are covered earlier, most manufacturing organizations usually divide their "goods for sale" inventory into:

Raw materials - materials and components scheduled for use in making a product. Work in progress, WIP - materials and components that have begun their transformation to finished goods. Finished goods - goods ready for sale to customers. Goods for resale - returned goods that are salable. Spare parts

• • •


Inventory is one aspect which can absorb a large portion of funds, if left unplanned or else save a substantial amount if properly planned and maintained. Most of the SME’s have a majority of their working capital blocked in inventory because of the following reasons: • Entrepreneurs are generally not aware about the ways and techniques to plan and manage inventory. As a result they tend to block more than required money in inventory. • Large enterprises normally follow the latest techniques for inventory management and as a result it is the SME’s which are forced to maintain inventory levels to meet the supply targets, as if they are unable to meet the targets they are liable to face penalty. •

Sometimes to negotiate with the suppliers for better rates, they are forced to buy more than required quantities of raw-material. In a volatile economic condition like the one prevalent now, due to fluctuating prices of raw-materials, the entrepreneurs tend to make wrong decisions regarding buying of raw-materials as it be both beneficial and fatal for the company.

The concept of SME’s is not new, nor is the problem faced by them. Since they are the real backbone of an economy the GOI has taken various measures to promote this category of industries, although not many have been benefited with the following measures listed below:

The GOI in consultation with various state governments took many steps to industrialize various states with a good number of units engaged in different trades spread throughout the state. The important measures that were taken in this regard are as follows: 27

• • • • • •

Provision of outlays for the development of roads and Transportation facilities. Establishment of Industrial Estates. Establishment of several Industrial Promotion Corporations and Agencies. Promotion of subsidies and incentives for the promotion of industries in the specified backward areas of the states. Development of Primary sector and there by to improve the resource Base to the agro based units. Provision of consultancy in the production, marketing, financial and Managerial areas through different state agencies.

The approach to develop SME industries by govt. will depend on: • • • • • Building skills and promoting technological development. Providing infrastructure and credit. Reforming policy and simplifying procedure. Providing assistance with marketing. Encouraging the development of special categories of entrepreneurs (women, scheduled castes and tribes, backward classes, etc).

Credit Guarantee Fund Scheme for Small and Medium Industries:There are an estimated 128.44 lakh registered and unregistered micro and small enterprises (MSEs) in the country at the end of March 2007, providing employment to an estimated 309.11 lakh persons. The MSE sector contributes about 39% of the manufacturing sector output and 33% of the nation’s exports. Of all the problems faced by the MSEs, non-availability of timely and adequate credit at reasonable interest rate is one of the most important. One of the major causes for low availability of bank finance to this sector is the high risk perception of the banks in lending to MSEs and consequent insistence on collaterals which are not easily available with these enterprises. The problem is more serious for micro enterprises requiring small loans and the first generation entrepreneurs.


The Credit Guarantee Fund Scheme for Micro and Small Enterprises (CGMSE) was launched by the Government of India to make available collateral-free credit to the micro and small enterprise sector. Both the existing and the new enterprises are eligible to be covered under the scheme. The Ministry of Micro, Small and Medium Enterprises and Small Industries Development Bank of India (SIDBI), established a Trust named Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) to implement the Credit Guarantee Fund Scheme for Micro and Small Enterprises. The scheme was formally launched on August 30, 2000 and is operational with effect from 1st January 2000. The corpus of CGTMSE is being contributed by the Government and SIDBI in the ratio of 4:1 respectively and has contributed Rs.1346.54 crore to the corpus of the Trust up to September 30, 2007. Based on the future requirement, the corpus is likely to be raised to Rs.2500 crore.

ELIGIBLE LENDING INSTITUTIONS The institutions, which are eligible under the scheme, are scheduled commercial banks (Public Sector Banks/Private Sector Banks/Foreign Banks) and select Regional Rural Banks (which have been classified under ‘Sustainable Viable’ category by NABARD). National Small Industries Corporation Ltd. (NSIC), North Eastern Development Finance Corporation Ltd. (NEDFi) and SIDBI have also been made eligible institutions. As on September 30, 2007, there are 62 Member Lending Institutions (MLIs) of the Trust, comprising 28 Public Sector Banks, 13 Private Sector Banks, 18 Regional Rural Banks and 3 other Institutions viz., NSIC, NEDFI and SIDBI. ELIGIBLE CREDIT FACILITY The credit facilities which are eligible to be covered under the scheme are both term loans and working capital facility up to Rs.50 lakh per borrowing unit, extended without 29

any collateral security or third party guarantee, to a new or existing micro and small enterprise. For those units covered under the guarantee scheme, which may become sick owing to factors beyond the control of management, rehabilitation assistance extended by the lender could also be covered under the guarantee scheme. It is noteworthy that if the credit facility exceeds Rs.50 lakh, it may still be covered under the scheme but the guarantee cover will be extended for credit assistance of Rs.50 lakh only. Another important requirement under the scheme is that the credit facility should be availed by the borrowing unit from a single lending institution. However, the unit already assisted by the State Level Institution/NSIC/NEDFi can be covered under the scheme for the credit facility availed from member bank, subject to fulfillment of other eligibility criteria. Any credit facility in respect of which risks are additionally covered under a scheme, operated by Government or other agencies, will not be eligible for coverage under the scheme.

SSSBE’s industry related service/ business enterprises with investment upto Rs 500,000 in fixed assets, excluding land and building, are called Small Scale Service/ Business Enterprises (SSSBE’s). This limit has been raised to Rs.1 million w.e.f. September 2000 Credit - The Lifeline Of Smes of all the elements that go into a business, credit is perhaps the most crucial. The best of plans can come to naught if adequate finance is not available at the right time. MSEs need credit support not only for running the enterprise & operational requirements but also for diversification, modernization/ up gradation of facilities, capacity, expansion etc. In respect of MSEs, the problem of credit becomes all the more critical when ever any episodic event occurs such as a large order, rejection of consignment, inordinate delay in payment etc. In general, MSEs operate on tight budgets, often financed through owner's own contribution, loans from friends and relatives and 30

some bank credit. Government of India recognized the need for a focused credit policy for MSEs in the early days of promotion of MSEs. This in turn led to a credit policy with the following components:-

Credit to the small scale sector is ensured as part of the priority sector lending by banks. Banks are required to compulsory ensure that defined percentage (currently 40%) of their overall lending is made to priority sectors as classified by Government. These sectors include agriculture, small industries, export etc. The inclusion of small industries in this list makes them eligible for this earmarked credit.

Nayak Committee set up by the Reserve Bank of India in December 1991 (Report came in September 1992) dealt with aspects of adequacy and timeliness of credit to SMEs. Nayak Committee found that SMEs was getting working capital to the extent of 8.1% of its annual output which was less than the normative requirement of 20%. Accordingly, Nayak Committee recommended that the SSI sector should obtain 20% of its annual projected turnover by way of working capital. Based on these, as well as other recommendations of the Nayak Committee, RBI issued a number of guidelines advising the banks to grant working capital to the extent of 20% of the projected annual turnover, timely disposal of loan applications and setting up of specialized bank branches for SME 31

loaning in areas of higher SME concentration. This norm is applicable to units with annual turnover up to Rs.5 crores.

As a follow up of Nayak Committee recommendations, the Union Finance Minister in the Budget Speech of 1995-96, announced a Seven Point Action Plan for improving the flow of credit to SME sector. This included:• • • • • • • • Setting up of specialized SSI bank branches; Adequate delegation of powers at branch and regional levels; Conducting sample surveys of their performing SME accounts by banks; Sanction of composite loans as far as possible; Regular meeting with SSI entrepreneurs; Sensitization of bank managers towards working of SME Sector; and Simplification of procedural formalities by banks. Action has been taken by banks on the above action plan.

Reserve Bank of India (RBI) had in December 1997 appointed a One Man Committee headed by Shri S.L. Kapur, the then Member, Board for Industrial & Financial Reconstruction (BIFR), to review inter-alia: the working of credit delivery system of SME industries with a view to making the system more effective, simple and efficient to administer; and to make suggestions for simplification and improvement in system and procedures. The Committee submitted its Report to RBI on 30th June 1998, which contains recommendations. Out of 126 recommendations, 103 have been examined by RBI and decision taken thereon. Banks/ Financial Institutions and other agencies have 32

already implemented 86 recommendations. Some of the important measures taken pursuant to the Recommendations of the Committee include:• • • • • Delinking of SIDBI from IDBI. Opening of more specialized branches. Enhancement in the limits of Composite Loan from Rs. 2 lakhs to Rs. 5 lakhs. Setting of DRTs. Introduction of Credit Guarantee Scheme.

NABARD is set up as an apex Development Bank with a mandate for facilitating credit flow for promotion and development of agriculture, smallscale industries, cottage and village industries, handicrafts and other rural crafts. It also has the mandate to support all other allied economic activities in rural areas, promote integrated and sustainable rural development and secure prosperity of rural areas. In discharging its role as a facilitator for rural prosperity NABARD is entrusted with: • • • • • • • Providing refinance to lending institutions in rural areas Bringing about or promoting institutional development and Evaluating, monitoring and inspecting the client banks Acts as a coordinator in the operations of rural credit institutions Extends assistance to the government, the Reserve Bank of India and other organizations in matters relating to rural development Offers training and research facilities for banks, cooperatives and organizations working in the field of rural development Helps the state governments in reaching their targets of providing assistance to eligible institutions in agriculture and rural development Acts as regulator for cooperative banks and RRBs 33

Besides this pivotal role, NABARD also:

SOME OF THE MILESTONES IN NABARD'S ACTIVITIES ARE: • • District Rural Industries Project (DRIP) has generated employment for 23.34 lakh persons with 10.95 lakh units in 105 districts. Credit functions, involving preparation of potential-linked credit plans annually for all districts of the country for identification of credit potential, monitoring the flow of ground level rural credit, issuing policy and operational guidelines to rural financing institutions and providing credit facilities to eligible institutions under various programmes • • Development functions, concerning reinforcement of the credit functions and making credit more productive Supervisory functions, ensuring the proper functioning of cooperative banks and regional rural banks

Indian economy in general and banking services in particular have made rapid strides in the recent past. However, a sizeable section of the population, particularly the vulnerable groups, such as weaker sections and low income groups, continue to remain excluded from even the most basic opportunities and services provided by the financial sector. To address the issue of such financial exclusion in a holistic manner, it is essential to ensure that a range of financial services is available to every individual. These services are: • • A no-frills banking account for making and receiving payments, A savings product suited to the pattern of cash flows of a poor household, 34

• • •

Money transfer facilities, Small loans and overdrafts for productive, personal and other purposes, & Micro-insurance (life and non-life)

In order to address the issues of financial inclusion, the Government of India constituted a “Committee on Financial Inclusion” under the Chairmanship of Dr. C. Rangarajan. The Committee submitted its final report to Hon'ble Union Finance Minister on 04 January 2008.

PURPOSE To meet gap in prescribed minimum promoters' contribution and/or in equity. ELIGIBLE BORROWERS Small and Medium entrepreneurs for setting up new projects in tiny / small scale sector and rehabilitation of potentially viable sick SME units irrespective of the location. Existing tiny and SME industrial units and service enterprises [tiny enterprises would include all industrial units and service industries (except Road Transport Operators) satisfying the investment ceiling prescribed for tiny enterprises] undertaking expansion, modernization, technology up gradation and diversification can also be considered irrespective of the location. NORMS • • • • Scheme operated through SFCs / twin function SIDCs / Scheduled Commercial Banks / Select Urban Co-operative Banks Cost of project - Not to exceed Rs.5 million Soft Loan limit - 25% of cost of project subject to a maximum of Rs.10, 00,000 per project. Service Charges - 5% p.a. on soft loan


• • • • SSIs Service sector units with project cost upto Rs.25 crore Medium Sector Enterprises (MSE) and Service sector units with project cost above Rs.25 crore and upto Rs.250 crore.

ELIGIBLE BORROWERS • • • • • New or existing SSI units. SSI unit graduating to medium scale, and Service sector units with an overall project cost not exceeding Rs.25 crore. New or existing medium sector enterprises, and Service sector units with an overall project cost above Rs.25 crore and upto Rs.250 crore with Bank's assistance not exceeding Rs. 50 crore. CONSTITUTION The unit should generally be a private limited / public limited company. However, partnership firms, sole proprietorship concerns and Societies and Trusts would also be considered on a case to case basis. The unit should generally be a private limited / public limited company NATURE OF ASSISTANCE Term loan and other forms of assistance such as Working Capital Term Loan and bills discounting (on selective basis). Term loan and other forms of assistance such as Working Capital Term Loan, suppliers' & purchasers' bills discounting. Investment products such as debentures, optionally convertible cumulative preference shares, zero coupon bonds, etc. CURRENCY OF LOAN In Rupee or foreign currency 36

In Rupee or foreign currency

PURPOSE TUFS has been launched with a view to sustaining as well as improving the competitiveness and overall long term viability of the textile sector. The scheme intends to provide timely and adequate capital at internationally comparable rates of interest in order to upgrade the textile industry's technology level. SPECIAL FEATURES For SSIs: The borrowers can avail of any one of the following benefits: 5% interest reimbursement on the interest actually charged in respect of rupee loan or coverage of exchange rate fluctuation not exceeding 5% p.a. from the base rate or cost of forward cover premium upto 5% p.a. on the base rate of exchange in respect of foreign currency OR 12% Credit Linked Capital Subsidy on eligible investment made for modernization, for SME Textile and Jute Industries in respect of Rupee Loans; The units are permitted to make new investment eligible under TUGS upto Rs. One crore or till the unit reaches SSI limit, whichever is higher. OR 20% Credit linked Capital subsidy (CLCS @20%) on machinery cost exclusively for power loom units in SSI sector. The cost of modern weaving machinery admissible is upto Rs. 60 lakh (i.e. Subsidy ceiling is Rs. 12 lakh). For units’ graduating out of SSI and Medium Sector Enterprises (MSEs): The borrowers can avail 5% interest reimbursement on the interest actually charged in respect of rupee loan or coverage of exchange rate fluctuation not exceeding 5% p.a. from the base rate or cost of forward cover premium upto 5% p.a. on the base rate of exchange in respect of foreign currency loan. ELIGIBLE BORROWERS 37

SME units, SME units graduating out of the sector after implementation of the scheme and MSEs in the Textile sector and Cotton Ginning and Pressing sector can be covered. Debt Equity Ratio Not to exceed 2:1 for the company/firm/concern as a whole

PURPOSE To enable manufacturers - sellers in SME sector / service sector including construction / selling agents to offer deferred payment terms for credit sales and realize sale proceeds by discounting bills of exchange / promissory notes arise out of such sales. ELIGIBLE BORROWERS Limits are sanctioned by SIDBI to well established concerns / corporate bodies buying machinery / capital equipment from SME units. Limits are also sanctioned to well established SME manufacturers - sellers NORMS Usance of Bills - Normally 3-5 years Minimum transaction value - Rs.1, 00,000

PURPOSE Assistance for equipment and/or working capital as also for work sheds ELIGIBLE BORROWERS Artisans, village and cottage industries and small and medium industries 38

NORMS Loan Limit - Not to exceed Rs.2.5 million

PURPOSE To provide both term loan for fixed assets and loan for working capital through the same agency. The total working capital requirement of such units inclusive of all fund based facilities may be taken into account for determining the working capital facility eligible for refinance ELIGIBLE BORROWERS Entrepreneurs setting up new projects in SSI / tiny sector, new promoters acquiring unencumbered fixed assets of existing SSI concerns from PLIs, as also existing well run units undertaking modernization / technology up gradation and potentially viable sick units undertaking rehabilitation scheme NORMS Scheme operated through SFCs / twin function IDCs / scheduled commercial banks / eligible state co-operative banks / scheduled urban cooperative banks Term Loan - Not to exceed Rs.20 million

Most of the research studies on financing of SMEs have highlighted the need to link availability of finance to SMEs to the delivery of business development to improve its viability. It is therefore necessary to evolve a model that shall provide for a partnership in 39

between SMEs and banks. The partnership concept takes care of sharing of risk in business proportionate to their respective financial involvement. Moreover, if we extend the partnership concept further, it would also help borrower to get more acceptable rate of interest. In fact, such partnership concept may lead to sharing of earnings instead of charging interest on loan as is prevalent in Islamic sharing of earnings instead of charging interest on loan as is prevalent in Islamic banking which of late is growing in importance due to present rise in oil prices. Moreover, it is necessary to build reliable information on SMEs to help assess market opportunities and risk management. There is also an urgent need to develop equity market for SMEs. This may be done by spreading success stories of SMEs in India. It has been the findings of many research studies that SMEs mostly depend upon external capital and this should not be only loans from banks but should be partly equity raised from the market besides the nominal equity held by the promoter. In this the supportive role of mutual funds and venture capitals could be of great help in developing capital market for SMEs. Further, securitization is another area to be developed to take care of non-performing assets (NPAs) that are blocking regular flow of funds to credit institutions catering to SMEs. It is obvious that in India gradually banks should adopt relationship lending technology and treat transaction lending technology as a complimentary and not a substitute strategy. Along with this risk cover and sharing of risk may help further improving SMEs financing by banks in India. Also more needs to be done to spread awareness about the various initiatives that are undertaken by the Government of India.


• • • • • • • • • • • • • • • • •


The following suggestions are made to resolve the various issues of Small Scale Sector.


The industry promoting agencies should take care of the well being of small scale sector and they should initiate such measures which would result in the further promotion of small scale units in the country.

It is right time to adopt the idea of limited partnership with a view to boost up the financial resources in small scale sector and to encourage small entrepreneurs to bear the risk.

• • •

Timely finance should be made available to the small units keeping in view their needs. The borrowings should be made cheaper by lowering the rate of interest on landings of commercial banks. The re-orientation program, workshops and seminars should be organized at district level to provide latest information about various schemes to the small entrepreneurs.

Banks should also provide consultancy services and professional guidance at the time of setting up for considering the long-term and short-term financial requirements of a small unit for lending purposes.

Small entrepreneurs should make feasibility studies before they finalize their projects. They should undertake only such projects which are technically, operationally and economically and financially viable.

The process followed by the government in sanctioning the loan is cumbersome; hence it is suggested to make the process easier in sectioning the credit facilities to the SMES.

The entrepreneurs are of the opinion that, the funding institutions are taking much time in sanctioning the loan. Hence it is suggested that the funding institutions should make the process easy required for offering credit to the entrepreneurs.

The Entrepreneurs are of the opinion that they are not getting proper assistance from the Government employees in documentation to obtain the loan from the funding institutions. Hence it is suggested that the government employees should be very cooperative and help the entrepreneurs in documentation for obtaining the credit. 42

The laws in place to safeguard the delayed payments of SME’s are weak at the implementation stage. A lot needs to be done to really make it effective. Infact it has been found that the government undertakings are also on the list of large enterprises that delay payments on a regular basis. So some corrective actions need to be taken by the GOI in this regard.

From the above major findings of the study the following conclusions are drawn: • The growth of small and medium scale industries in the country has been significant in the recent past. 43

• • • • • •

Various backward/remote areas are moving towards industrialization through Small and medium Scale Sector. Industrial promoting agencies have made a mark in the development of state as well as the district industrially. Capital base of small units is very poor and they are facing several financial crisis. Shortage of finance is the main problem responsible for a host of problems. The SMEs are not aware of the credit schemes offered by the commercial banks and nodal agencies. The delays in sanctioning of the loan and the neglecting attitude of the bank officials are the main causes behind the bad perception of SMEs towards the banks.

• •

The Central Government should take the initiative in propagating the credit facilities for the SMEs through the channel of NGOs. Financial problems are the root cause for all the problems faced by the SMEs. The State Government should encourage this segment through its Finance Corporation.

The entrepreneurs should be motivated to run successfully of their units by taking the advantage of various credit facilities



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